Why Inflation in The Gambia is a Structural Phenomenon, Not Monetary

1. Introduction

Inflation is a persistent concern for many economies, and The Gambia is no exception. The Central Bank of The Gambia (CBG) has employed various measures, including interest rate adjustments, to curb inflationary pressures. However, despite these efforts, inflation remains stubbornly high. The critical question is: why? If we do not get this fundamental issue right, we risk looking for answers in the wrong place.

The answer lies in the nature of inflation in The Gambia, which is more structural than monetary. Unlike advanced economies where inflation is often driven by excessive money supply, The Gambia's inflation is rooted in deeper structural deficiencies. Consequently, monetary policy tools like interest rate hikes are largely ineffective in addressing the problem.

Milton Friedman famously stated that “inflation is always and everywhere a monetary phenomenon.” His argument suggests that inflation is primarily driven by excessive money supply growth. While this holds in many advanced economies with strong monetary transmission mechanisms, The Gambia’s inflation dynamics challenge this assertion. In The Gambia, inflation is more structural than monetary, meaning that monetary policy tools like interest rate hikes are largely ineffective in addressing the root causes. 

2. Evidence from Monetary Policy Trends

The accompanying figure 1 and 2, which represent money supply (M2),  Inflation,  the Monetary Policy Rate (MPR), and 3-month Treasury Bills Rate, further supports the argument that inflation in The Gambia is structural rather than monetary.

Source:CBG, Macroeconomic Data Warehouse 

Figure 1: Money Supply and Inflation Rate

Figure 2: Monetary Policy Rate, 3 Months Treasury Bills Rate and Inflation

2.1 Key observations from the graph include:

• Inflation and money supply exhibited divergent tends, with inflation continuing to increase even during episodes of low money growth. This suggest inflation in The Gambia is driven by factors other than money supply.

• Inflation trends tend to rise even when MPR remains relatively high, suggesting that external and supply-side factors, rather than domestic liquidity conditions, are driving price increases.

• The decoupling of inflation from monetary policy signals reinforces the argument that structural reforms are necessary to address persistent inflationary pressures.

• Despite significant fluctuations in MPR and T-bills rates, inflation does not respond proportionally, indicating that interest rate adjustments have a limited impact on price stability.

• T-bill rates are not responding effectively to changes in MPR in Figure 2, which suggests weak monetary transmission mechanisms. The lack of synchronization between MPR and Treasury yields highlights inefficiencies in the financial system, limiting the effectiveness of interest rate policy in controlling inflation.

3. Evidence Based on Structure of the Economy

• The Import-Dependent Nature of the Economy

The Gambia is heavily reliant on imports for essential goods, including food, fuel, and raw materials. This dependence means that global supply chain disruptions, exchange rate fluctuations, and external price shocks have a direct impact on domestic prices. When global fuel prices rise or when the dalasi depreciates against major currencies, the cost of imports surges, leading to higher inflation. No amount of interest rate adjustment can resolve this fundamental issue.

• Supply-Side Constraints

Agriculture, which is a significant part of the Gambian economy, suffers from low productivity due to inadequate infrastructure, farming techniques, and vulnerability to climate shocks. The limited domestic production capacity forces the country to rely on imports, making prices susceptible to external influences. Without addressing these structural constraints, inflation will continue to persist, irrespective of monetary policy interventions.

• Exchange Rate Volatility

The Gambia operates under a flexible exchange rate regime, making the dalasi highly susceptible to external shocks. Given that a significant portion of the country’s consumer goods are imported, any depreciation of the dalasi immediately translates into higher prices (inflation pass-through). While raising interest rates might help stabilize the currency to some extent, it does little to address the root causes of exchange rate fluctuations, such as trade imbalances and low foreign exchange reserves.

• Structural Rigidities in the Labor Market

The Gambian labor market is characterized by a large informal sector and low productivity, which contribute to stagnant wages and reduced purchasing power. This creates a wage-price lag rather than a wage-price spiral, meaning inflation is not primarily driven by rising wages but rather by external price shocks (e.g., rising import costs). Addressing labor market inefficiencies requires long-term policy solutions rather than short-term monetary interventions.

• Supply Chain and Logistical Challenges

Poor infrastructure and inefficient logistics contribute significantly to high inflation. The cost of transporting goods within the country remains elevated due to poor road networks and high fuel costs. Additionally, the loss of competitiveness of the Banjul Port to Senegal has exacerbated supply chain disruptions. With most goods now being imported through Senegal and then transported to The Gambia, businesses face higher logistical costs, customs inefficiencies, and delays, all of which further inflate consumer prices. These structural inefficiencies create bottlenecks that drive up costs across the economy. Addressing these challenges requires strategic investment in infrastructure and trade facilitation measures rather than relying solely on interest rate hikes.

3. A More Effective Approach: Structural Reforms

Given the structural nature of inflation in The Gambia, policy solutions must go beyond monetary measures. The following structural reforms could provide a more sustainable path to price stability:

• Diversification of the Economy: Investing in agriculture and manufacturing can reduce reliance on imports and mitigate external price shocks.
• Enhancing Domestic Production: Improving productivity in key sectors will help stabilize prices by reducing the need for imports.
• Strengthening Exchange Rate Stability: Policies aimed at boosting exports and attracting foreign investment can help build foreign exchange reserves and stabilize the dalasi.
• Improving Infrastructure: Better transportation networks, energy supply, and logistics will lower production and distribution costs, thereby reducing inflationary pressures.
• Climate Adaptation Strategies: Since The Gambia is vulnerable to climate shocks, investing in climate-resilient agriculture and water management can help stabilize food supply and prices.

4. Conclusion

Inflation in The Gambia is deeply rooted in structural deficiencies, making monetary policy tools like interest rate hikes insufficient for long-term price stability. The evidence from historical monetary policy trends shows that inflation remains high despite significant changes in interest rates. Additionally, the weak response of T-bills rates to MPR adjustments suggests inefficiencies in the financial system, further reducing the effectiveness of monetary policy. Addressing the real causes of inflation requires comprehensive structural reforms aimed at enhancing production, improving infrastructure, and reducing import dependency. Without these changes, inflationary pressures will persist, regardless of adjustments in interest rates.

Given the structural nature of inflation, using the policy rate as a symbolic gesture (we are doing something) makes more sense than relying on it as a blunt instrument. Thus, CBG should use monetary policy primarily as a signaling tool rather than a direct inflation-fighting mechanism.